Households "sort" across neighborhoods according to their wealth and their
preferences for public goods, social characteristics, and commuting opportunities. The
aggregation of these individual choices in markets and in other institutions influences
the supply of amenities and local public goods. Pollution, congestion, and the quality
of public education are examples. Over the past decade, advances in economic models
of this sorting process have led to a new framework that promises to alter the ways we
conceptualize the policy evaluation process in the future. These "equilibrium sorting"
models use the properties of market equilibria, together with information on household
behavior, to infer structural parameters that characterize preference heterogeneity.
The results can be used to develop theoretically consistent predictions for the welfare
implications of future policy changes. Analysis is not confined to marginal effects
or a partial equilibrium setting. Nor is it limited to prices and quantities. Sorting
models can integrate descriptions of how nonmarket goods are generated, estimate
how they affect decision making, and, in turn, predict how they will be affected by
future policies targeting prices or quantities. Conversely, sorting models can predict
how equilibrium prices and quantities will be affected by policies that target product
quality, information, or amenities generated by the sorting process. These capabilities
are just beginning to be understood and used in applied research. This survey article
aims to synthesize the state of knowledge on equilibrium sorting, the new possibilities
for policy analysis, and the conceptual and empirical challenges that define the
frontiers of the literature.